UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Transition Period From ____________TO _____________
COMMISSION FILE NUMBER 001-10651
-----------
MAVERICK TUBE CORPORATION
16401 Swingley Ridge Road
Seventh Floor
Chesterfield, Missouri 63017
(636) 733-1600
State or other jurisdiction of incorporation or organization - Delaware
I.R.S. Employee Identification No. - 43-1455766
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes XX No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes XX No --
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, $0.01 Par Value - 42,644,311 shares as of November 2, 2004
- --------------------------------------------------------------------------------
MAVERICK TUBE CORPORATION AND SUBSIDIARIES
INDEX
- --------------------------------------------------------------------------------
PAGE NO.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited) 3
Condensed Consolidated Balance Sheets - September 30, 2004
and December 31, 2003 3
Condensed Consolidated Statements of Income - Three and Nine
Months Ended September 30, 2004 and 2003 4
Condensed Consolidated Statements of Cash Flows - Nine
Months Ended September 30, 2004 and 2003 5
Notes to Condensed Consolidated Financial Statements 7
Report of Independent Registered Public Accounting Firm 15
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 29
Item 4. Controls and Procedures 30
PART II. OTHER INFORMATION
Item 6. Exhibits 31
SIGNATURES 32
EXHIBIT INDEX 33
2
- --------------------------------------------------------------------------------
MAVERICK TUBE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
- --------------------------------------------------------------------------------
September 30, December 31,
2004 2003
(Unaudited)
-------------------------
ASSETS
Current assets:
Cash and cash equivalents.......................... $ 31,727 $ 29,202
Short-term investments............................. 40,303 -
Accounts receivable, less allowances of $6,751 and
$5,414 on September 30, 2004 and December 31,
2003, respectively............................... 172,961 117,115
Inventories........................................ 356,334 184,025
Deferred income taxes.............................. 6,347 5,534
Income taxes refundable............................ 591 590
Prepaid expenses and other current assets.......... 11,198 6,267
-------------------------
Total current assets................................... 619,461 342,733
Property, plant and equipment, net of accumulated
depreciation of $170,977 and $151,331 on September
30, 2004 and December 31, 2003, respectively....... 198,635 189,434
Goodwill............................................... 85,984 82,982
Other acquired intangibles, net of accumulated
amortization....................................... 34,718 35,304
Note receivable........................................ - 9,500
Other assets........................................... 12,056 10,773
-------------------------
$950,854 $670,726
=========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................... $ 88,468 $ 47,557
Accrued expenses and other liabilities............. 44,371 34,391
Deferred revenue................................... 9,466 3,386
Income taxes payable............................... 38,829 203
Current maturities of long-term debt............... 3,165 3,533
-------------------------
Total current liabilities.............................. 184,299 89,070
Long-term debt, less current maturities................ 3,203 4,209
Convertible senior subordinated notes.................. 120,000 120,000
Revolving credit facility.............................. 67,591 50,213
Other liabilities...................................... 15,825 16,436
Deferred income taxes.................................. 9,561 6,000
STOCKHOLDERS' EQUITY
Preferred stock, $0.01 par value per share; 5,000,000
authorized shares; 1 share issued and outstanding.. - -
Common stock, $0.01 par value per share; 80,000,000
authorized shares; 42,589,311 and 42,001,662 shares
issued and outstanding at September 30, 2004 and
December 31, 2003, respectively.................... 426 420
Additional paid-in capital............................. 237,495 227,048
Unamortized value of restricted stock.................. (3,210) -
Retained earnings...................................... 317,463 162,192
Accumulated other comprehensive loss................... (1,799) (4,862)
-------------------------
Total stockholders' equity............................. 550,375 384,798
-------------------------
$950,854 $670,726
=========================
See accompanying notes to condensed consolidated financial statements.
3
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MAVERICK TUBE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
- --------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
-------------------------------------------------
Net sales...................... $400,684 $226,753 $1,060,070 $641,116
Cost of goods sold............. 266,672 196,988 736,254 580,796
-------------------------------------------------
Gross profit................... 134,012 29,765 323,816 60,320
Selling, general and
administrative................ 21,975 15,716 64,218 39,814
Partial trade case relief...... (740) (950) (740) (950)
-------------------------------------------------
Income from operations......... 112,777 14,999 260,338 21,456
Interest expense............... 2,076 2,711 7,371 7,153
-------------------------------------------------
Income before income taxes and
cumulative effect of an
accounting change............. 110,701 12,288 252,967 14,303
Provision for income taxes..... 42,168 3,611 96,112 4,321
-------------------------------------------------
Income before cumulative effect
of an accounting change....... 68,533 8,677 156,855 9,982
Cumulative effect of an
accounting change (net of
benefit for income taxes of
$951)......................... - - (1,584) -
-------------------------------------------------
Net income..................... $ 68,533 $ 8,677 $ 155,271 $ 9,982
=================================================
Basic earnings per share
Income before cumulative
effect of an accounting
change..................... $ 1.62 $ 0.21 $ 3.71 $ 0.24
Cumulative effect of an
accounting change.......... - - (0.04) -
-------------------------------------------------
Net income................... $ 1.62 $ 0.21 $ 3.67 $ 0.24
=================================================
Diluted earnings per share
Income before cumulative
effect of an accounting
change..................... $ 1.60 $ 0.21 $ 3.68 $ 0.24
Cumulative effect of an
accounting change.......... - - (0.04) -
-------------------------------------------------
Net income................... $ 1.60 $ 0.21 $ 3.64 $ 0.24
=================================================
See accompanying notes to condensed consolidated financial statements.
4
- --------------------------------------------------------------------------------
MAVERICK TUBE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
- --------------------------------------------------------------------------------
Nine Months Ended
September 30,
2004 2003
-------------------------
OPERATING ACTIVITIES
Net income............................................. $155,271 $ 9,982
Adjustments to reconcile net income to net cash
provided by operating activities:
Cumulative effect of an accounting change.............. 1,584 -
Depreciation........................................... 17,876 15,561
Amortization........................................... 2,104 1,172
Deferred income taxes.................................. 2,138 221
Provision for losses on accounts receivable............ 601 609
Loss (Gain) on sale of equipment....................... 1 (1)
Changes in operating assets and liabilities, net of
effect of acquisitions:
Accounts receivable................................. (45,443) (23,857)
Inventories......................................... (153,498) 45,128
Prepaid expenses and other current assets........... (4,208) 2,224
Other assets........................................ (5,873) 794
Accounts payable.................................... 35,082 (40,098)
Accrued expenses and other liabilities.............. 46,050 8,480
Deferred revenue.................................... 6,080 2,687
-------------------------
Cash provided by operating activities.................. 57,765 22,902
INVESTING ACTIVITIES
Cash paid for acquisitions, net of cash received....... (22,012) (4,000)
Expenditures for property, plant and equipment......... (19,254) (13,046)
Purchase of short-term investments..................... (40,303) -
Proceeds from disposal of equipment.................... 5,835 63
Other.................................................. 549 -
-------------------------
Cash used by investing activities...................... (75,185) (16,983)
FINANCING ACTIVITIES
Net (repayments) borrowings on revolving credit
facility............................................. 17,591 (88,192)
Proceeds from convertible senior subordinated notes.... - 120,000
Principal payments on long-term borrowings and notes... (3,670) (2,167)
Deferred debt costs.................................... (353) (4,494)
Principal payments on long-term notes receivable....... 313 250
Proceeds from exercise of stock options................ 5,628 1,902
-------------------------
Cash provided by financing activities.................. 19,509 27,299
Effect of exchange rate changes on cash................ 436 690
-------------------------
Increase in cash and cash equivalents.................. 2,525 33,908
Cash and cash equivalents at beginning of period....... 29,202 2,551
------------------------
Cash and cash equivalents at end of period............. $ 31,727 $36,459
========================
5
Supplemental disclosures of cash flow information:
Noncash investing and financing activities:
Net assets consolidated from a cumulative effect of
an accounting change............................. $ 11,492 $ -
Stock issued for acquisitions...................... $ - $12,104
Debt issued for acquisitions....................... $ - $ 5,000
See accompanying notes to condensed consolidated financial statements.
6
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MAVERICK TUBE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
- --------------------------------------------------------------------------------
(1) BASIS OF PRESENTATION
- --------------------------------------------------------------------------------
The unaudited, condensed, consolidated financial statements include the accounts
of Maverick Tube Corporation and its direct and indirect wholly-owned
subsidiaries, collectively referred to as the "Company." All significant
intercompany accounts and transactions have been eliminated. The accompanying
condensed, consolidated financial statements include the financial statements of
Maverick Tube L.P. ("Maverick"), Prudential Steel Ltd. ("Prudential"), Precision
Tube Technology, L.P. ("Precision"), Maverick C&P, Inc. doing business as
"Republic Conduit", SeaCAT Corporation ("SeaCAT"), since its acquisition on
February 28, 2003 and Pennsylvania Cold Drawn, LLC ("PCD"), since its
consolidation on March 31, 2004.
The accompanying unaudited, condensed, consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and notes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring items) considered necessary for a
fair presentation have been included. Operating results for the nine months
ended September 30, 2004 are not necessarily indicative of the results that may
be expected for the year ended December 31, 2004. For further information, refer
to the consolidated financial statements and notes thereto included in the
Company's Annual Report on Form 10-K for the year-ended December 31, 2003.
(2) RECENT ACCOUNTING PRONOUNCMENTS
- --------------------------------------------------------------------------------
In January 2003, the Financial Accounting Standards Board issued Interpretation
No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51," which was revised in December 2003. FIN 46
requires an investor who receives the majority of the expected losses, the
expected residual returns, or both ("primary beneficiary") of a variable
interest entity ("VIE") to consolidate the assets, liabilities and results of
operations of the entity. A VIE is an entity in which the equity investors do
not have a controlling interest or the equity investment at risk is insufficient
to finance the entity's activities without receiving additional subordinated
financial support from other parties.
On March 29, 2002, pursuant to an asset purchase agreement dated March 21, 2002,
the Company completed the sale of the Cold Drawn Tubular Business ("DOM")
business to PCD for $8,115,000, consisting of $1,238,000 cash and the buyer's
nine-year secured promissory note for $6,877,000. In November 2003, the Company
restructured the buyer's promissory note in exchange for the release of
Maverick's guarantee of certain payment obligations and obtained additional
security including the buyer's personal guarantee and increased the outstanding
note obligation. As of September 30, 2004, the Company holds three PCD notes
receivable totaling $9,662,000 and accounts receivable of $4,394,000, against
which we have reserved $7,256,000. These accounts are eliminated in
consolidation (see below).
During the first quarter of 2004, the Company adopted the provisions of FIN 46
with respect to PCD, which is a VIE as defined under FIN 46. As the Company was
deemed the primary beneficiary, it was required to consolidate PCD as of March
31, 2004. As a result, the Company recognized a non-cash charge of $1,584,000
(net of benefit for income taxes of $951,000), reflecting the cumulative losses
of PCD from the time of the sale on March 29, 2002, as a cumulative effect of an
accounting change in the accompanying Condensed Consolidated Statements of
Income. The third-party creditors of PCD have no recourse to the general credit
of the Company.
7
The unaudited pro forma amounts below reflect the retroactive application of FIN
46 as if the Company had adopted the standard on January 1, 2003 and the
corresponding elimination of the cumulative effect of an accounting change (in
thousands, except per share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2004 2003
---------------------------------------
Net income (pro forma)..................... $8,588 $156,767 $8,417
Basic earnings per share (pro forma)....... $ 0.20 $ 3.71 $ 0.20
Diluted earnings per share (pro forma)..... $ 0.20 $ 3.67 $ 0.20
The above pro forma results include adjustments to give effect of intercompany
transactions and are not necessarily indicative of the operating results that
would have occurred nor are they necessarily indicative of future operating
results.
(3) BUSINESS ACQUISITIONS
- --------------------------------------------------------------------------------
Texas Arai
On April 23, 2004, Maverick acquired substantially all of the assets and certain
liabilities of Texas Arai, Inc. ("Texas Arai"), a subsidiary of Grant Prideco,
Inc., a publicly-held, Houston-based oilfield service manufacturer, for a
purchase price of $20,412,000. The acquisition was accounted for as a purchase
business combination, and the financial statements of Texas Arai have been
consolidated from the acquisition date. The cost to acquire Texas Arai has been
preliminarily allocated to the assets acquired and liabilities assumed according
to their estimated fair values as described below. The finalization of the
working capital adjustment is subject to adjustment between Maverick and Grant
Prideco, Inc. Texas Arai is the largest North American provider of American
Petroleum Institute and premium-grade couplings used to connect tubing and
casing in oil and gas wells. The Company acquired Texas Arai to add
premium-grade couplings to its product line.
Following is a summary of the net assets and liabilities acquired (in
thousands):
Texas Arai
-------------
Purchase price (including transaction costs)................ $20,412
Assets acquired:
Cash...................................................... 1
Accounts receivable....................................... 4,290
Inventory................................................. 13,989
Property, plant and equipment............................. 5,091
Other assets.............................................. 176
-------------
23,547
Liabilities acquired:
Accounts payable.......................................... (2,632)
Other accruals............................................ (503)
-------------
(3,135)
Net assets acquired....................................... 20,412
-------------
Goodwill.................................................... $ -
=============
8
(4) INVENTORIES
- --------------------------------------------------------------------------------
Inventories at September 30, 2004 and December 31, 2003 consist of the following
(in thousands):
September 30, December 31,
2004 2003
-------------------------
Finished goods......................................... $179,991 $ 98,575
Work-in-process........................................ 31,426 10,252
Raw materials.......................................... 133,265 63,023
Storeroom parts........................................ 11,652 12,175
-------------------------
$356,334 $184,025
=========================
Inventories are principally valued at the lower of average cost or market.
(5) REVOLVING CREDIT FACILITY
- --------------------------------------------------------------------------------
The Company has a senior credit facility (due on March 31, 2006) providing for
an $185,000,000 revolving line of credit. At September 30, 2004, we had an
outstanding balance of $67,591,000 against the line and outstanding letters of
credit under this agreement of $3,816,000. Interest is payable monthly at the
LIBOR rate adjusted by an interest margin, depending upon certain financial
measurements. Under the senior credit facility, the Company can borrow an amount
based on a percentage of eligible accounts receivable, eligible inventory and
property, plant and equipment, reduced by outstanding letters of credit. The
additional available borrowings under the senior credit facility were
approximately $101,100,000 and the applicable interest rate was 3.9% per annum
as of September 30, 2004. The senior credit facility includes restrictive
covenants relating to maintaining a minimum fixed charge coverage ratio if
availability falls below $30,000,000. Also, if availability falls below
$50,000,000, the debt will be classified as current. The senior credit facility
also limits capital expenditures to $30,000,000 per year and limits the
Company's ability to pay dividends, create liens, sell assets or enter into
transactions with affiliates without the consent of the lenders.
(6) CONVERTIBLE SENIOR SUBORDINATED NOTES
- --------------------------------------------------------------------------------
In June 2003, the Company issued $120,000,000 of contingent convertible senior
subordinated notes (the "Convertible Notes") due June 15, 2033. The Company pays
interest semi-annually on the Convertible Notes at the rate of 4.0% per annum.
Beginning with the six-month interest period commencing on June 15, 2008, the
Company will pay contingent interest during a six-month interest period if the
average trading price of the Convertible Notes equals or exceeds 130.0% of the
principal amount of the Convertible Notes during a specified period prior to
such six-month interest period. The embedded derivative related to this
contingent interest feature is required to be valued separately from the
Convertible Note; however, the fair value of this derivative is not material at
September 30, 2004.
The Convertible Notes are general unsecured obligations of the Company and are
subordinated to the Company's present and any future senior indebtedness. Also,
the Convertible Notes are convertible under certain limited circumstances into
shares of the Company's common stock at an initial conversion rate of 34.2583
shares of the Company's common stock per $1,000 principal amount of the
Convertible Notes, representing a conversion price of $29.19 per common share.
The Company has the right under certain conditions to redeem the Convertible
Notes after June 15, 2008 at a redemption price equal to par plus accrued
interest, if any. From June 15, 2008 to June 15, 2011, the Company may redeem
the Convertible Notes only if the closing price of the Company's common stock
has exceeded 130.0% of the conversion price then in effect over 20 trading days
out of a period of 30 consecutive trading days. After June 15, 2011, the Company
may redeem the Convertible Notes at any time. Holders of the Convertible Notes
have the right to require the Company to repurchase all or some of their
Convertible Notes on June 15, 2011, 2013, 2018, 2023 and 2028 at a price equal
to par plus accrued interest, if any, payable in cash. Holders of the
Convertible Notes also
9
have the right to require the Company to purchase all or some of their
Convertible Notes at a price equal to par plus accrued interest, if any, if
certain change of control events occur prior to June 15, 2011.
During the September 2004 meeting of the Emerging Issues Task Force ("EITF"), a
consensus was reached on EITF Issue 04-8, "The Effect of Contingently
Convertible Debt on Diluted Earnings per Share." EITF 04-8 requires companies to
include certain convertible debt and equity instruments that were previously
excluded into their calculations of diluted earnings per share. The EITF
concluded that Issue 04-8 will be effective for periods ending after December
15, 2004, and must be applied by restating all periods during which time the
applicable convertible instruments were outstanding. As further discussed in
Note 12, shares issued upon conversion of the Company's 4.0% senior convertible
notes issued in 2003 will be included in the Company's diluted earnings per
share calculation in periods where the Company reported net income applicable to
common shareholders.
(7) DERIVATIVES, FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
- --------------------------------------------------------------------------------
Derivative Instruments and Hedging Activities
- ---------------------------------------------
Certain activities of the Company expose it to market risks, including the
effects of changes in foreign currency exchange rates and interest rates. The
financial exposures are monitored and managed by the Company as an integral part
of its overall risk management program. The Company's risk management program
seeks to reduce the potentially adverse effects that the volatility of the
markets may have on its operating results.
The Company maintains an interest rate risk management strategy that may, from
time to time, use derivative instruments to minimize significant, unanticipated
earnings fluctuations caused by interest rate volatility.
The Company maintains a foreign currency risk management strategy that uses
derivative instruments to protect its interests from unanticipated fluctuations
in earnings and cash flows caused by volatility in currency exchange rates. The
Company does not hold or issue financial instruments for trading purposes, nor
does it hold or issue leveraged derivative instruments.
The Company generally uses cash flow hedging strategies to reduce the
potentially adverse effects that market volatility may have on its operating
results. Cash flow hedges are hedges of forecasted transactions or of the
variability of cash flows to be received or paid related to a recognized asset
or liability. The Company enters into foreign exchange forward contracts
generally expiring within six months with the objective of converting U.S.
denominated debt held by the Company's Canadian subsidiary, Prudential, into its
functional currency. These contracts protect against the risk that the eventual
cash flows resulting from such transactions will be adversely affected by
changes in exchange rates. The Company also uses interest rate swaps to convert
a portion of its variable rate revolving credit facility to fixed rates, which
generally expire in six months.
Accounting for Derivatives and Hedging Activities
- -------------------------------------------------
The Company formally documents at inception all relationships between hedging
instruments and hedged items, as well as its risk management objective and
strategy for undertaking various hedged items. The Company also formally
assesses, both at the hedge's inception and on an ongoing basis, whether the
derivatives used in hedging transactions are highly effective in offsetting
changes in fair value or cash flows of the hedged items. Changes in the fair
value of a derivative that is highly effective as, and that is designated and
qualifies as, a cash flow hedge are recorded in other comprehensive earnings,
until the underlying transactions occur. When it is determined a derivative is
not highly effective as a hedge or it has ceased to be a highly effective hedge,
the Company discontinues hedge accounting prospectively.
10
The following table summarizes the notional transaction amounts and fair values
for the Company's outstanding derivatives, by risk category and instrument type,
at September 30, 2004 (in thousands):
Notional Fair Value
Qualifying Cash Flow Hedges Amount Asset/(Liability) Description
- --------------------------------------------------------------------------------
Interest rate swaps $50,000 $ (32) Effectively converts
the interest rate on
(floating to an eqivalent amount
fixed rate swaps) variable rate
borrowings to a
fixed rate
Foreign currency hedges $30,000 $(1,504) Effectively hedges the
(floating to variability in
fixed exchange rates) forecasted cash flows
due to the foreign
currency risk
associated with the
settlement of
nonfunctional
currency denominated
debt
The ineffective portion of these hedges was immaterial as of September 30, 2004
and the Company expects these hedges to remain highly effective.
(8) DEFINED BENEFIT PLANS
- --------------------------------------------------------------------------------
Prudential sponsors two pension plans and a postretirement benefit plan for
substantially all of its Canadian employees and a supplemental executive
retirement plan ("SERP") for certain former key Prudential executives. Expected
contributions for the year ended December 31, 2004 (in thousands) are as
follows:
Pension
Benefits Postretirement
and SERP Benefit Plan
---------------------------------
Contributions required by funding
regulations or laws........................ $1,306 $ -
Additional discretionary contributions....... 2,459 95
---------------------------------
$3,765 $95
=================================
Benefit costs consist of the following for the three and nine months ended
September 30, 2004 and 2003 (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
-------------------------------------------------
Pension benefit costs:
Service cost................... $452 $376 $1,217 $1,130
Interest cost.................. 832 633 2,241 1,901
Expected return on plan assets. (738) (564) (1,988) (1,692)
Amortization of prior service
cost......................... 130 61 349 181
Amortization of transition
asset........................ (180) (159) (485) (475)
Recognized net actuarial gain.. 103 172 278 514
-------------------------------------------------
$599 $519 $1,612 $1,559
=================================================
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
-------------------------------------------------
Postretirement benefit plan
costs:
Service cost................... $ 42 $14 $ 72 $ 44
Interest cost.................. 75 30 135 88
Recognized net actuarial loss.. 53 15 80 43
-------------------------------------------------
$170 $59 $287 $175
=================================================
11
(9) SEGMENT INFORMATION
- --------------------------------------------------------------------------------
The Energy Products segment includes revenue and operating expenses associated
with those products and services of the Company sold to the energy industry,
such as oil country tubular goods ("OCTG"), line pipe, coiled steel pipe,
premium couplings and tolling services. The Industrial Products segment includes
revenue and operating expenses associated with those products of the Company
sold to the industrial industry, such as electrical conduit, rigid conduit,
structural shapes and rounds, standard pipe, mechanical tubing and pipe piling.
The following table sets forth data (in thousands) for the three and nine months
ended September 30, 2004 and 2003, regarding the reportable industry segments of
the Company. Intersegment sales are not material. Identifiable assets are those
used in the Company's operations in each segment.
Energy Industrial
Products Products Corporate Total
-------------------------------------------------
Three months ended September 30, 2004
- -------------------------------------
Net sales...................... $256,412 $144,272 $- $ 400,684
Income from operations......... 61,717 51,060 - 112,777
Identifiable assets............ 614,715 238,911 97,228 950,854
Nine months ended September 30, 2004
- ------------------------------------
Net sales...................... $658,574 $401,496 $- $1,060,070
Income from operations......... 133,740 126,598 - 260,338
Identifiable assets............ 614,715 238,911 97,228 950,854
Three months ended September 30, 2003
- -------------------------------------
Net sales...................... $159,101 $ 67,652 $- $ 226,753
Income from operations......... 13,389 1,610 - 14,999
Identifiable assets............ 410,694 149,718 83,241 643,653
Nine months ended September 30, 2003
- ------------------------------------
Net sales...................... $442,710 $198,406 $- $ 641,116
Income from operations......... 20,812 644 - 21,456
Identifiable assets............ 410,694 149,718 83,241 643,653
The corporate information in the above table is not considered a segment;
however, it represents the corporate assets necessary for the day-to-day
operations of the Company (that are not identifiable to the reporting segments).
(10) STOCK-BASED COMPENSATION
- --------------------------------------------------------------------------------
The Company has three employee stock option plans and three stock option plans
for eligible directors allowing for incentive and non-qualified stock options.
The Company also has an Omnibus Incentive Plan in which restricted stock has
been granted to certain employees of the Company. Effective January 1, 2003, the
Company adopted SFAS No. 148, "Accounting for Stock-Based Compensation," which
allows the Company to continue to account for stock option plans under the
intrinsic value method in accordance with Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, no
stock-based employee compensation cost is reflected in net income as all options
granted under those plans had an exercise price equal to the market value of the
underlying common stock on the date of grant. Compensation expense is recognized
in net earnings for restricted stock grants.
12
Pursuant to the disclosure requirements of SFAS No. 123, "Accounting for
Stock-Based Compensation," as amended by SFAS No. 148, pro forma net income and
earnings per share are presented in the table below as if compensation cost for
stock options was determined as of the grant date under the fair value method
(in thousands, except per share information):
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
-------------------------------------------------
Net income, as reported........ $68,533 $8,677 $155,271 $9,982
Add: total stock-based employee
compensation expense included
in reported net earnings, net
of related tax effects........ 417 - 539 -
Deduct: total stock-based
employee compensation expense
determined under fair
value-based method for all
awards, net of related tax
effects...................... (740) (621) (1,310) (1,615)
-------------------------------------------------
Pro forma net income........... $68,210 $8,056 $154,500 $8,367
=================================================
Basic earnings per share
Net income - as reported..... $ 1.62 $ 0.21 $ 3.67 $ 0.24
Net income - pro forma....... $ 1.61 $ 0.19 $ 3.66 $ 0.20
Diluted earnings per share
Net income - as reported..... $ 1.60 $ 0.21 $ 3.64 $ 0.24
Net income - pro forma....... $ 1.59 $ 0.19 $ 3.62 $ 0.20
SFAS No. 123 requires the use of option pricing models that were not developed
for use in valuing employee stock options. Further, option pricing models
require the input of highly subjective assumptions, including the options'
expected life and price volatility of the underlying stock. Thus, in the opinion
of management, existing option pricing models do not necessarily provide a
reliable measure of the fair value of employee stock options.
The pro forma compensation expense associated with the fair value of the options
calculated for the nine months ended September 30, 2004 and 2003 is not
necessarily representative of the potential effects on reported net income
(loss) in future periods. The fair value of each option grant is estimated on
the date of the grant by use of the Black-Scholes option pricing model.
(11) CAPITAL STOCK
- --------------------------------------------------------------------------------
On June 11, 2000, the Company and Prudential entered into a Business Combination
Agreement providing for the combination of Prudential with the Company. Under
the terms of the transaction, Prudential stockholders received 0.52 of an
exchangeable share, issued by Maverick Tube (Canada) Inc., a wholly-owned
Canadian subsidiary of the Company, for each Prudential common share.
Consequently, Prudential stockholders received a total of 15,813,088
exchangeable shares that began trading on The Toronto Stock Exchange on
September 27, 2000. These shares have the same voting rights, dividend and
distribution entitlements, and other attributes as shares of the Company's
common stock and are exchangeable, at each stockholder's option, for the
Company's common stock on a one-for-one basis. The transaction was accounted for
as a pooling of interests.
In conjunction with the Prudential transaction, the Company's Board of Directors
designated one share of the Company's authorized preferred stock as Special
Voting Stock. The Special Voting Stock is entitled to a number of votes equal to
the number of outstanding exchangeable shares of Maverick Tube (Canada) Inc., on
all matters presented to the common stockholders of the Company. The one share
of Special Voting Stock is issued to CIBC Mellon Trust Company, as trustee
pursuant to the Voting and Exchange Trust Agreement among the Company, Maverick
Tube (Canada) Inc. and CIBC Mellon Trust Company, for the benefit of the holders
of the exchangeable shares of Maverick Tube (Canada) Inc. For financial
statement purposes, the exchangeable shares that have not been exchanged for
shares of the Company's common stock have been treated as if they had been
exchanged and are included in the Company's outstanding shares of common stock.
13
As long as any exchangeable shares of Maverick Tube (Canada) Inc. are
outstanding, the Special Voting Stock may not be redeemed, the number of shares
comprising the Special Voting Stock shall not be increased or decreased and no
other term of the Special Voting Stock shall be amended, except upon the
unanimous approval of all common stockholders of the Company. If the Special
Voting Stock is purchased or otherwise acquired by the Company, it shall be
deemed retired and cancelled. Thereafter, it will become an authorized but
unissued and undesignated preferred share of the Company.
(12) EARNINGS PER COMMON SHARE
- --------------------------------------------------------------------------------
Basic earnings per share exclude any dilutive effects of restricted stock, stock
options and the effect of the conversion of the Convertible Notes, but include
the exchangeable shares (as further described in Note 11) from the business
combination with Prudential on an as-if exchanged basis. Diluted earnings per
share include the exchangeable shares on an as-if exchanged basis and the net
effect of unvested restricted stock and stock options, but exclude the effect of
the conversion of the Convertible Notes.
The reconciliation for diluted earnings per share for each of the three and nine
months ended September 30, 2004 and 2003, is as follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
-------------------------------------------------
Average shares outstanding..... 42,399 41,936 42,270 41,669
Dilutive effect of unvested
restricted stock and
outstanding stock options.... 464 318 408 367
-------------------------------------------------
Average shares deemed
outstanding.................. 42,863 42,254 42,678 42,036
=================================================
Income before cumulative effect
of an accounting change used
in the calculation of basic
and diluted earnings per share $68,533 $8,677 $156,855 $9,982
Cumulative effect of an
accounting change used in the
calculation of basic and
diluted earnings per share.... - - (1,584) -
-------------------------------------------------
Net income used in the
calculation of basic and
diluted earnings per share... $68,533 $8,677 $155,271 $9,982
=================================================
(13) COMPREHENSIVE INCOME
- --------------------------------------------------------------------------------
The following table sets forth the components of other comprehensive income for
each of the three and nine months ended September 30, 2004 and 2003 (in
thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2004 2003 2004 2003
-------------------------------------------------
Net income..................... $68,533 $8,677 $155,271 $ 9,982
Change in fair value of cash
flow hedges.................. (195) (110) 192 (611)
Foreign currency translation
adjustment................... 5,158 283 2,900 6,351
Minimum pension liability
adjustment................... (76) (20) (29) (296)
-------------------------------------------------
Comprehensive income........... $73,420 $8,830 $158,334 $15,426
=================================================
14
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Maverick Tube Corporation
We have reviewed the condensed consolidated balance sheet of Maverick Tube
Corporation and subsidiaries as of September 30, 2004, and the related condensed
consolidated statements of income for the three-month and nine-month periods
ended September 30, 2004 and 2003, and the condensed consolidated statements of
cash flows for the nine-month periods ended September 30, 2004 and 2003. These
financial statements are the responsibility of the Company's management.
We conducted our review in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures to financial
data, and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with the standards of the Public Company Accounting Oversight Board (United
States), the objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.
Based on our review, we are not aware of any material modifications that should
be made to the condensed consolidated financial statements referred to above for
them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheet of Maverick Tube Corporation and subsidiaries as of December 31, 2003, and
the related consolidated statements of income, stockholders' equity, and cash
flows for the year then ended [not presented herein] and in our report dated
February 6, 2004, we expressed an unqualified opinion on those consolidated
financial statements. In our opinion, the information set forth in the
accompanying condensed consolidated balance sheet as of December 31, 2003, is
fairly stated, in all material respects, in relation to the consolidated balance
sheet from which it has been derived.
/s/ Ernst & Young LLP
St. Louis, Missouri
October 29, 2004
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- -------------------------------------------------------------------------------
As used herein, Maverick Tube Corporation and its direct and indirect
wholly-owned subsidiaries are collectively referred to as "the Company." Our
operating subsidiaries consist of: Maverick Tube L.P. ("Maverick"), Prudential
Steel Ltd. ("Prudential"), Precision Tube Technology, L.P. ("Precision"),
Maverick C&P, Inc. doing business as "Republic Conduit", SeaCAT Corporation
("SeaCAT") and our consolidated variable interest entity, Pennsylvania Cold
Drawn, LLC ("PCD"). Also, unless the context otherwise requires, the terms "we,"
"us" or "our" refer to the Company.
Certain statements contained in the "Management's Discussion and Analysis of
Financial Condition and Results of Operations" section of this report regarding
matters (including statements as to beliefs or expectations) that are not
historical facts are forward-looking statements, as that term is defined under
the Private Securities Litigation Reform Act of 1995. Because such
forward-looking statements include risks and uncertainties, actual results may
differ materially from those expressed or implied by such forward-looking
statements. For example, uncertainty continues to exist as to future levels and
volatility of oil and gas price expectations and their effect on drilling levels
and demand for our energy-related products, the future impact of industry-wide
draw-downs of inventories, future import levels and the value of the U.S.
dollar. Also, uncertainty continues to exist as to the price of steel (our
principal raw material, representing approximately eighty percent of cost of
goods sold).
It is not possible to foresee or identify all factors that could have a material
and negative impact on the future financial performance of the Company. The
forward-looking statements in this report are based on certain assumptions and
analyses we have made in light of our experience and perception of historical
conditions, expected future developments and other factors we believe
appropriate under the circumstances. Further information covering issues that
could materially affect our financial performance is contained in the "Risk
Factors" section of our Annual Report on Form 10-K for the year ended December
31, 2003, filed with the Securities and Exchange Commission on March 8, 2004.
This information can be found on the Company's web site at www.mavericktube.com.
Our condensed, consolidated financial statements have been prepared in
accordance with accounting principles generally applied in the United States. It
should be noted that the application of certain accounting estimates of the
Company require judgment and/or estimates of management that could have a
significant impact on amounts reported in these financial statements. In
particular, the accounting for and analysis with respect to areas such as
goodwill, accounts receivable collectibility, income tax matters and pension
plan matters are discussed. These critical accounting estimates are more fully
described in the section entitled "Management's Discussion and Analysis of
Financial Condition and Results of Operations" of our 2003 Annual Report on Form
10-K.
The market data and other statistical information used throughout this quarterly
report are based on independent industry publications, government publications,
and reports by market research firms or other published independent sources.
Some data are also based on our good faith estimates that are derived from our
review of internal surveys as well as certain industry-specific independent
sources. Although we believe these sources are reliable, we have not
independently verified the information and cannot guarantee its accuracy and
completeness.
All dollar amounts are expressed in U.S. currency unless otherwise indicated.
OVERVIEW
- --------------------------------------------------------------------------------
Maverick Tube Corporation is a leading producer of welded tubular steel products
used in energy and industrial applications throughout the world. We are the
largest North American producer of oil country tubular goods (sometimes referred
to as OCTG) and line pipe products for use in newly drilled oil and gas wells
and for transporting oil and natural gas. We go to market on both a direct and
distribution basis in the U.S. and Canada. We expanded our business into coiled
tubing products with our acquisitions of Precision and SeaCAT. Coiled tubing
products are used typically to maintain existing wells and to complete new
wells. We sell coiled tubing to customers throughout North America and
internationally. We further expanded our business into American Petroleum
Institute ("API") and premium grade couplings by acquiring substantially all of
the assets and certain
16
liabilities of Texas Arai, the largest North American producer of API and
premium grade couplings. API and premium grade couplings are used to connect
tubing and casing in oil and gas wells. OCTG, line pipe, coiled tubing products
and premium grade couplings comprise our energy product line.
We also manufacture structural tubing, which is generally referred to as hollow
structural sections or HSS, standard pipe and pipe piling. In January 2003, we
entered the steel electrical conduit business with our acquisition of Republic
Conduit. Structural tubing, standard pipe, pipe piling and steel electrical
conduit products comprise our industrial product line. We sell these industrial
products to service centers, fabricators and end-users.
Recent Business Acquisitions
- ----------------------------
On February 28, 2003, we completed the acquisition of SeaCAT, a then
privately-held, Houston-based, coiled tubular goods manufacturer, in exchange
for $4.0 million cash, a $5.0 million secured, 11.0% subordinated note and
733,676 shares of common stock of the Company. The purchase price could be
further increased by up to an additional $0.5 million if SeaCAT achieves certain
performance targets through 2005.
On April 23, 2004, we completed the acquisition of substantially all of the
assets and certain liabilities of Texas Arai, Inc., a subsidiary of Grant
Prideco, Inc., a publicly-held, Houston-based, oilfield service manufacturer,
for a purchase price of $20,412,000 cash.
Energy Products Demand and Consumption
- --------------------------------------
OCTG
Demand for our energy-related products depends primarily upon the number of oil
and natural gas wells being drilled, completed and worked over in the U.S. and
Canada and the depth and drilling conditions of these wells. The levels of these
activities are primarily dependent on oil and natural gas prices. Many factors,
such as the supply and demand for oil and natural gas, general economic
conditions and global weather patterns, influence these prices. As a result, the
future level and volatility of oil and natural gas prices are uncertain. In
addition, seasonal fluctuations impact our customers and the demand for our
products to some extent. For instance, weather conditions during the second and
third quarters make drilling more difficult in western Canada. Consequently,
drilling activity and the corresponding demand for our products is lower at this
time in western Canada.
U.S. end-users obtain OCTG not only from domestic and foreign pipe producers,
but also from draw-downs of inventory held by end-users, distributors or mills.
Accordingly, industry inventory levels, which can change significantly from
period to period, is another indicator of demand for our products. Canadian
distributors and end users do not generally hold significant amounts of
inventories.
17
The following table illustrates certain factors related to industry-wide
drilling activity, energy prices, OCTG consumption, shipment, imports and
inventories for the periods presented:
Three Months Ended
September 30,
2004 2003
-------------------------
U.S. Market Activity:
Average rig count...................................... 1,229 1,088
=========================
Average U.S. energy prices:
Oil per barrel (West Texas Intermediate)........... $43.93 $30.26
=========================
Natural gas per MCF (Average U.S.)................. $ 5.36 $ 4.87
=========================
U.S. OCTG Consumption:
(in thousands of tons)
U.S. producer shipments............................ 572 486
Imports............................................ 261 201
Inventory (increase)/decrease...................... (36) (10)
Used pipe.......................................... 14 18
-------------------------
Total U.S. Consumption 811 695
=========================
Canadian Market Activity:
Average rig count...................................... 326 383
=========================
Average Canadian energy prices:
Natural gas per U.S. $ per MCF
(Average Alberta spot price)....................... $ 4.64 $ 4.18
=========================
Canadian OCTG Consumption:
(in thousands of tons)
Canadian producer shipments........................ 138 140
Imports............................................ 82 88
Inventory (increase)/decrease...................... (28) (6)
-------------------------
Total Canadian Consumption..................... 192 222
=========================
The U.S. rig count in the above table is based on weekly rig count
reporting from Baker Hughes, Inc. Average U.S. energy prices in the above
table are monthly average period prices as reported by Spears and
Associates for West Texas Intermediate grade crude oil and the average U.S.
monthly natural gas cash prices as reported by Natural Gas Week. U.S. OCTG
imports are as reported by Duane Murphy and Associates in "The OCTG
Situation Report." U.S. OCTG inventory (increase)/decrease is our estimate
based upon independent research by Duane Murphy and Associates. U.S. used
pipe quantities are calculated by multiplying 8.3 recoverable tubing and
casing tons by the number of abandoned oil and gas wells. U.S. consumption
of OCTG is our estimate based on estimated per rig consumption of OCTG
multiplied by the Baker Hughes rig count. U.S. producer shipments are our
estimates based on the components listed above.
The Canadian rig count in the above table is based on weekly rig count
reporting from Baker Hughes, Inc. Average Canadian energy prices in the
above table are the average Alberta natural gas spot prices. Canadian OCTG
imports are as reported by Statistics Canada. Canadian OCTG inventory
(increase)/decrease is our estimate based upon data reported by Statistics
Canada. Canadian producer shipments are reported by Statistics Canada Steel
Pipe and Tube Report. Canadian producer shipments are our estimates based
on the components listed above.
According to published industry reports, average U.S. drilling for the third
quarter of 2004 was approximately 1,229 rigs, representing an increase of 13.0%
compared to the third quarter of 2003. Natural gas drilling increased by 13.7%,
while oil-related drilling increased by 9.2%. The higher drilling levels for
both oil and natural gas were primarily attributable to increases in oil and
natural gas prices, up by 45.2% and 10.1%, respectively. As of the date of this
report, the current rig count in the U.S. is 1,268.
According to published industry reports, average Canadian drilling for the third
quarter of 2004 was approximately 326 rigs, representing a decrease of 14.9%
compared to the third quarter of 2003 due to poor weather conditions during the
quarter. Natural gas drilling levels remained strong as natural gas prices
continue to be well above historical prices. As of the date of this report, the
current rig count in Canada is 432.
Import market share increased from 28.9% during the third quarter of 2003 to
32.2% during the third quarter of 2004. During the third quarter of 2004, U.S.
producer shipments of OCTG increased by 17.7% as compared to the comparable
prior year period. During that period, U.S. producer shipments were positively
impacted by industry
18
inventory increases that resulted in a 4.4% increase in demand. Management
believes that at September 30, 2004, industry inventories were still below
historical levels in relation to demand as inventory months of supply decreased
4.1%, from 4.9 months of supply for the third quarter of 2003 to 4.7 months of
supply for the third quarter of 2004.
As a result of the increased drilling activity, we estimate total U.S.
consumption increased by 16.7% in the third quarter of 2004 compared to the
prior year quarter. Over the same periods, our domestic shipments of OCTG
increased 9.5%, and our export sales, primarily to Canada, decreased by 49.2%.
We estimate our domestic OCTG market share declined 6.9% during the quarter
ended September 30, 2004 as compared to the quarter ended September 30, 2003.
The 17.5% market share we captured during the quarter ended September 30, 2004
is comparable to our historical market share. We lost market share in the U.S.
as we pushed pricing higher than some of our competitors.
Import market share increased from 39.6% during the third quarter of 2003 to
42.7% during the third quarter of 2004. The increase in market share was
primarily due to the importation of lower priced OCTG, primarily from the Far
East, in the third quarter of 2004 compared to the third quarter of 2003. During
the third quarter of 2004, Canadian producer shipments of OCTG decreased by 1.4%
compared to the prior year quarter. Canadian shipments in the third quarter of
2004 decreased as drilling activity decreased for the third quarter of 2004 as
compared to the prior year quarter.
As a result of the decrease in drilling activities, we estimate total Canadian
consumption decreased by 13.5% in the third quarter of 2004 compared to the
prior year quarter. Over the same periods, our Canadian shipments of OCTG
decreased 21.0%. Also, we estimate our Canadian OCTG market share of domestic
shipments decreased from 37.0% during the quarter ended September 30, 2003 to
32.3% during the quarter ended September 30, 2004. We lost market share in
Canada as we pushed pricing higher than some of our competitors.
Line Pipe
Published information suggests U.S. demand for line pipe (under 16") decreased
during the third quarter of 2004 by an estimated 1.3% from the third quarter of
2003 and domestic shipments increased by 2.6%, as the import market share
decreased from 33.2% to 30.6%. Canadian demand for line pipe (under 16")
decreased during the third quarter of 2004 from the prior year quarter by an
estimated 14.3%, and domestic shipments decreased by 14.5%. Import market share
increased from 28.6% in the third quarter of 2003 to 53.0% in the third quarter
of 2004. The increase in the import market share was primarily due to a large
seamless line pipe project in Alberta, Canada using product from Argentina and
Mexico.
Coiled Tubing
Coiled down-hole tubing is primarily used to service existing oil and gas wells
to reestablish well production and extend well life. Commodity pricing and
industry cash flow are primary drivers of well service work and demand for
coiled down-hole tubing. E&P industry cash flows increased during the third
quarter of 2004 by an estimated 23.4%, from $40.1 billion in the third quarter
of 2003 to $49.5 billion in the third quarter of 2004. This was primarily due to
increases in the average natural gas prices of 10.1% year over year in the third
quarter, and by a 45.2% increase in the price of crude oil in the same period.
For 2004, published forecasts of U.S. well service and work-over projects
predict spending will rise 11.7%, with service and work-over rig activity up
7.3%. In the third quarter of 2004, U.S. work-over rig counts averaged 1,260
working rigs, up 8.5% from an average of 1,164 active rigs in the third quarter
of 2003. In Canada, recent published forecasts for 2004 indicate well service
and work-over expenditures will increase 13.0%, with rig activity and jobs up
7.6% and 6.6%, respectively.
Coiled line pipe is used in offshore, sub-sea applications where continuous
lengths of steel line pipe are used as flow lines. Umbilical tubing is used as
sheathing for sub-sea well controls. For offshore applications, coiled line pipe
is more cost-effective compared to traditional jointed line pipe as it allows
for much more rapid installation, which reduces overall installed costs. Recent
published forecasts for U.S. offshore spending in 2004 call for up to $10.5
billion in spending, down slightly from $10.7 billion in 2003. Third quarter
U.S. offshore spending of $2.6 billion was down slightly from the third quarter
of 2003 as many offshore projects continued to be deferred. We expect the
decrease in offshore spending to continue to impact 2004 sales in this segment
of our business in the U.S.
19
Our coiled line pipe is also sold in international offshore drilling markets.
International offshore spending is forecasted to increase to $27.6 billion in
2004, up 4.3% from 2003. Average offshore rig activity is projected to reach an
average of 229 units in 2004, up 2.2% from 2003, and offshore well completions
are forecasted at 2,136 wells, up 1.6% over 2003. In the third quarter of 2004,
offshore spending was flat, rig activity of 221 was up 2.8%, and offshore well
completions were down 3.2% to 519 wells as compared to the third quarter of
2003.
Industrial Products Demand and Consumption
- --------------------------------------------------------------------------------
Given the numerous applications for industrial products, sources of demand for
these products are diverse. Demand depends on the general level of economic
activity in the construction, transportation, agricultural, material handling
and recreational market segments, the use of structural tubing as a substitute
for other structural steel forms, such as I-beams and H-beams, and draw-downs of
existing customer inventories.
We estimate the U.S. demand for structural tube products of the type we produce
increased 0.8% during the third quarter of 2004 over the prior year period.
Total U.S. producer shipments decreased 8.1% during the third quarter of 2004
over the prior year period as import market share increased from 20.0% to 27.0%.
Electrical conduit is primarily used as sheathing for electrical and computer
wiring in industrial, commercial and institutional construction, which are
classified as non-residential construction. As such, electrical conduit demand
is primarily influenced by changes in spending on non-residential construction.
Published forecasts for non-residential construction activity in 2004 show a
modest decrease of 0.1% from 2003 compared to the 4.6% decrease experienced in
2003 from 2002. We estimate the U.S. demand for electrical conduit of the types
we produce seasonally decreased by approximately 20% during the third quarter of
2004 as compared to the prior year period due primarily to inventory reductions
by our customers. The Company and three other domestic producers manufacture
most of the electrical conduit consumed in the U.S.
Standard pipe is used primarily in construction applications for transporting
water, steam, gases, waste and other similar gases and fluids. Demand for this
product is primarily affected by general economic activity and non-residential
construction expenditures. According to published reports and management
estimates, preliminary numbers indicate U.S. standard pipe demand in the third
quarter of 2004 was up from the same period last year by about 2.1%. While
domestic shipments were down 12.6% to 347,500 tons, the domestic producers share
of the market decreased from 64.5% in 2003 to 55.2% in the third quarter of
2004. Imports increased from 35.5% of shipments in the third quarter of 2003 to
44.8% in the third quarter of 2004.
Pricing and Costs of Our Products
- ---------------------------------
Pricing of our products was up during the third quarter of 2004 compared to the
third quarter of 2003. Pricing of our U.S. OCTG, line pipe, standard product,
structural product and conduit product pricing increased by 82.2%, 92.0%, 77.1%,
149.4% and 151.8%, respectively. Pricing of our Canadian energy products and
industrial products was up 48.4% and 98.7%, respectively, compared to the
comparable prior year quarter. Canadian prices were impacted by a 5.6% increase
in the exchange rate.
Since December 2003, we have raised prices on all our shipments in order to pass
along to end-users the steel surcharges and base price increases our steel
vendors have included on steel purchased by us. These price increases across our
entire product line are designed to absorb the anticipated increase in the cost
of steel, our principal raw material. Given the mix of our U.S. alliance sales
and volume of our Canadian OCTG business, the timing and the extent to which our
future price increases can be realized are uncertain. No assurance can be given
that we will succeed in implementing future price increases sufficient to fully
absorb the anticipated steel cost increases described below.
Average steel costs included in cost of goods sold increased during the third
quarter of 2004 over the third quarter of 2003 by $216 per ton, or 65.1%. We
expect our replacement cost of steel will continue to rise in both the U.S. and
Canada given that steel vendors have implemented increases in base price and
surcharges due to the escalating cost of scrap and tight supplies. Current
replacement cost is up approximately 26% over the cost of goods sold reflected
in the income statement for the quarter ended September 30, 2004. In December
2003, one of our major steel
20
suppliers implemented an unprecedented scrap surcharge based upon the American
Metal Market's Consumer Buying Price for No. 1 Busheling. The surcharge has
fluctuated monthly based on scrap prices. The surcharges for June, July, August,
September, October and November 2004 are $70 per ton, $80 per ton, $180 per ton,
$225 per ton, $210 per ton, and $210 per ton, respectively. During the fourth
quarter of 2004, we expect that our reported steel costs may increase by as much
as $200 per ton, or almost 50% higher than the steel component of cost of goods
sold reflected in our 2004 third quarter earnings. We expect the replacement
cost of steel to remain volatile throughout the remainder of 2004. However, the
magnitude and timing of further steel costs changes are unknown at this time.
Purchased steel represents approximately three-quarters of our cost of goods
sold. As a result, the steel industry, which is highly volatile and cyclical in
nature, affects our business both positively and negatively. Numerous factors,
most of which are beyond our control, drive the cycles of the steel industry and
influence steel prices, including general economic conditions, industry capacity
utilization, import duties and other trade restrictions and currency exchange
rates. Changes in steel prices had a significant impact on the margin levels of
our energy products because energy product pricing historically has been driven
by OCTG and line pipe demand. Given that steel costs have escalated so
dramatically, OCTG and line pipe producers passed steel cost increases through
to their customers in the form of steel surcharges and base price increases.
In addition, we depend on a few suppliers for a significant portion of our
steel. Because steel is ultimately a commodity, the loss of one of our
significant steel suppliers or the inability to obtain the necessary amount of
steel could have a temporary adverse effect on our ability to produce the
quantity of products necessary to sustain our market share, thus impacting our
results of operations.
Impact of Market Conditions
- ---------------------------
The increase in drilling levels and steel surcharges during the third quarter of
2004 resulted in higher sales. Industry-wide inventory levels increased
modestly. As recent experience indicates, oil and gas prices are volatile and
can have a substantial effect on drilling levels and resulting demand for our
energy-related products. Uncertainty also exists as to the future demand and
pricing for our electrical conduit, HSS and other industrial-related products.
Trade Cases
- -----------
U.S. Line Pipe - In early March 2004, an antidumping petition was filed with the
U.S. government covering line pipe from China, the Republic of South Korea, and
Mexico. In April 2004, the U.S. International Trade Commission ("USITC") ruled
unanimously that imports of line pipe under 16 inch in outside diameter from the
three named countries were being sold in the United States at less than fair
value resulting in injury to the U.S. industry. As a result of the USITC's
affirmative determinations, the U.S. Department of Commerce (DOC) has continued
its antidumping investigations of imports of certain circular welded carbon line
pipe from these countries. The DOC issued preliminary margins of 73.17 percent
for China, 14.93 to 31.34 percent for Mexico, and made a preliminary de minimis
determination with respect to Korea, with margins of 1.2 to 1.3 percent falling
below the 2 percent de minimis level. The DOC will conduct verifications and
issue final determinations in December 2004 for China, and February 2005 for
Mexico and Korea. The USITC will issue its final determinations by March 2005.
The Company is unable to predict the outcome of these investigations at this
time.
In mid 2003, the Canadian Border Security Agency initiated an inquiry into
imports of HSS into Canada from the Republic of South Korea, the Republic of
Turkey and the Republic of South Africa. Imports of HSS from the named countries
into Canada can affect our Canadian HSS selling prices and volumes. The Canadian
Border Security Agency determined that imports from the three named countries
were dumped into Canada at significant margins. The Canadian International Trade
Tribunal ruled that imports from all three countries had injured the domestic
industry in Canada. Final dumping margins were assessed against all three
countries ranging from an average of 89% on imports from South Korean, 55.4% on
South African imports and 17.5% on imports from Turkey. These dumping margins
will apply on all imports of HSS from the named countries until August 2008.
21
RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
Overall Company
- ---------------
The following table illustrates the operating results and tons shipped for the
three and nine month periods ended September 30, 2004 and 2003 (in millions,
except per share data and tons shipped):
Three Months Ended September 30, 2004 vs. 2003
2004 2003 Change % Change
----------------------------------------------------
Energy tons shipped......... 209,635 215,933 (6,298) (2.9%)
Industrial tons shipped..... 93,211 105,103 (11,892) (11.3%)
---------------------------------------------------
Total tons shipped.......... 302,846 321,036 (18,190) (5.7%)
Net sales................... $400.7 $226.8 $173.9 76.7%
Cost of goods sold.......... 266.7 197.0 69.7 35.4%
---------------------------------------------------
Gross profit................ 134.0 29.8 104.2 NM
Income from operations...... 112.8 15.0 97.8 NM
Income before income taxes.. 110.7 12.3 98.4 NM
Net income.................. 68.5 8.7 59.8 NM
Diluted earnings per share.. 1.60 0.21 1.39 NM
Nine Months Ended September 30, 2004 vs. 2003
2004 2003 Change % Change
---------------------------------------------------
Energy tons shipped.......... 645,817 637,292 8,525 1.3%
Industrial tons shipped...... 331,046 304,449 26,597 8.7%
---------------------------------------------------
Total tons shipped........... 976,863 941,741 35,122 3.7%
Net sales.................... $1,060.1 $641.1 $419.0 65.4%
Cost of goods sold........... 736.3 580.8 155.5 26.8%
---------------------------------------------------
Gross profit................. 323.8 60.3 263.5 NM
Income from operations....... 260.3 21.5 238.8 NM
Income before income taxes
and cumulative effect of
an accounting change...... 253.0 14.3 238.7 NM
Income before cumulative
effect of an accounting
change.................... 156.9 10.0 146.9 NM
Net income................... 155.3 10.0 145.3 NM
Diluted earnings per share
before cumulative effect
of an accounting change... 3.68 0.24 3.43 NM
Diluted earnings per share... 3.64 0.24 3.40 NM
NM Not meaningful
Net sales of $400.7 million recorded for the third quarter of 2004 represent an
increase of $173.9 million, or 76.7%, compared to the prior year period. These
results were primarily attributable to increases in overall average net selling
prices from the comparable quarter of the prior year by 87.4%, from an average
of $706 per ton to $1,323 per ton. The increase we experienced in average net
selling prices primarily resulted from strengthening energy market conditions
and steel surcharges charged to our customers to offset steel cost increases
implemented by our major steel suppliers. For the third quarter of 2004, there
was a 5.7% decrease in total product shipments, from 321,036 tons in the third
quarter of 2003 to 302,846 tons in the third quarter of 2004. Product shipments
decreased as we raised our prices more aggressively than our competitors. See
"Overview."
Net sales of $1,060.1 million recorded for the nine months ended September 30,
2004 represent an increase of $419.0 million, or 65.4%, compared to the prior
year period. These results were primarily attributable to an increase in overall
average net selling prices from the comparable period of the prior year by
59.3%, from an average of $681 per ton to $1,085 per ton. For the nine months
ended September 30, 2004, there was a 3.7% increase in total product shipments,
from 941,741 tons for the nine months ended September 30, 2003 to 976,863 tons
for the nine months ended September 30, 2004. The increase we experienced in
shipments and average net selling prices primarily resulted from strengthening
energy market conditions and steel surcharges charged to our customers to offset
steel cost increases implemented by our major steel suppliers. See "Overview."
22
Cost of goods sold of $266.7 million recorded for the third quarter of 2004
represents an increase of $69.7 million, or 35.4%, compared to the prior year
period. Overall unit cost per ton of products sold increased 43.5% in the third
quarter of 2004 from the comparable quarter of the prior year, from an average
of $614 per ton to $881 per ton. Costs increased primarily due to an increase in
steel prices experienced in the third quarter of 2004 as compared to the third
quarter of 2003. We expect our current replacement cost of steel to flow through
our cost of goods sold over the next two quarters. See "Overview."
Cost of goods sold of $736.3 million recorded for the nine months ended
September 30, 2004 represents an increase of $155.5 million, or 26.8%, compared
to the prior year period. Overall unit cost per ton of products sold increased
22.2% in the nine months ended September 30, 2004 from the comparable prior year
period, from an average of $617 per ton to $754 per ton. Costs increased
primarily due to an increase in steel prices experienced for the nine months
ended September 30, 2004 compared to the prior year. See "Overview."
The Company earned gross profit of $134.0 million during the third quarter of
2004, compared to gross profit of $29.8 million in the prior year period. Gross
profit per ton was $442 per ton in the third quarter of 2004 as compared to $93
per ton in the comparable prior year period. Accordingly, gross profit, as a
percentage of net sales, was 33.4% for the three-month period ended September
30, 2004 compared to 13.1% for the comparable prior year period. Gross profit
per ton primarily increased due to strengthening market conditions in both our
energy and industrial product lines and the sale of generally lower cost
inventory at higher selling prices charged by the Company in response to
increasing steel costs and strong market conditions. We expect the higher steel
costs will continue to flow through our inventory in the fourth quarter of 2004
and the first quarter of 2005. Depending on the conditions in our respective
product markets and to the extent that higher steel costs cannot be absorbed
through increased sale prices, these higher steel costs could impact our gross
profit margins in the fourth quarter of 2004 and the first quarter of 2005.
The Company earned gross profit of $323.8 million during the nine months ended
September 30, 2004, compared to gross profit of $60.3 million in the prior year
period. Gross profit per ton was $331 per ton for the nine months ended
September 30, 2004, as compared to $64 per ton in the comparable prior year
period. Accordingly, gross profit, as a percentage of net sales, was 30.5% for
the nine-month period ended September 30, 2004 compared to 9.4% for the
comparable prior year period. Gross profit per ton primarily increased due to
strengthening market conditions in both our energy and industrial product lines
and the sale of generally lower cost inventory at higher selling prices charged
by the Company in response to increasing steel costs and strong market
conditions. We expect the higher steel costs will continue to flow through our
inventory in the fourth quarter of 2004 and the first quarter of 2005. Depending
on the conditions in our respective product markets and to the extent that
higher steel costs cannot be absorbed through increased sale prices, these
higher steel costs could impact our gross profit margins in the fourth quarter
in 2004 and the first quarter of 2005.
Selling, general and administrative expenses increased $6.3 million, or 40.1%,
from $15.7 million in the third quarter of 2003 to $22.0 million in the third
quarter of 2004. The increase resulted primarily from additional commission
expense on our industrial product line, additional reserves for allowance for
doubtful accounts, write-downs on our joint venture and variable interest
investments and charges related to business development activities. Selling,
general and administrative expenses as a percentage of net sales in the third
quarter of 2004 were 5.5% compared to 6.9% for the comparable prior year period.
The decrease resulted primarily from the increase in net sales.
Selling, general and administrative expenses increased $24.4 million, or 61.3%,
from $39.8 million during the nine months ended September 30, 2003 to $64.2
million during the nine months ended September 30, 2004. The increase resulted
primarily from the additional commission expense on our industrial product line,
additional reserves for allowance for doubtful accounts, incentive compensation,
and write-downs on our joint venture and variable interest investments and
charges related to business development activities. Selling, general and
administrative expenses as a percentage of net sales in the nine months ended
September 30, 2004 were 6.1% compared to 6.2% for the comparable prior year
period. The decrease resulted primarily from the increase in net sales.
The Company recognized a $0.7 million recovery for the trade case outstanding
with the Department of Commerce during the third quarter of 2004. Payments will
be made to various companies, including Maverick, under the Continued Dumping &
Offset Act of 2000, ("CDSOA") to cover certain expenses including investment in
23
manufacturing facilities and acquisition of technology incurred after the
imposition of antidumping and anti-subsidy measures. We cannot predict the
amounts or the certainty of any future recoveries associated with CDSOA. Because
these expenses were included in operating income in previous years, we recorded
the recovery as a separate line item included in operating income to
consistently reflect the effect of this payment on operations.
Interest expense decreased $0.6 million, or 22.2%, from $2.7 million in the
third quarter of 2003 to $2.1 million in the third quarter of 2004. This
decrease was due to lower average borrowings and lower average interest rates
during the third quarter of 2004 as compared to the third quarter of 2003.
Interest expense increased $0.2 million, or 2.8%, from $7.2 million for the nine
months ended September 30, 2003 to $7.4 million for the nine months ended
September 30, 2004. This increase was due to higher average borrowings partially
offset by lower average interest rates for the nine months ended September 30,
2004 as compared to the comparable prior year period.
The results of our operations resulted in generation of pre-tax income of $110.7
million for the third quarter of 2004 compared to pre-tax income in the third
quarter of 2003 of $12.3 million. Accordingly, the provision for income taxes
was $42.2 million for the third quarter of 2004 compared to the comparable prior
year period's provision of $3.6 million. The effective tax rate for the quarter
was impacted by the generation of more pre-tax income and a greater proportion
of that income was derived from U.S. operations.
The results of our operations resulted in generation of pre-tax income of $253.0
million for the nine months ended September 30, 2004 compared to pre-tax income
for the nine months ended September 30, 2003 of $14.3 million. Accordingly, the
provision for income taxes was $96.1 million for the nine months ended September
30, 2004 compared to the comparable prior year period's provision of $4.3
million. The effective tax rate for the nine months ended September 30, 2004 was
impacted by the generation of more pre-tax income and a greater proportion of
that income was derived from U.S. operations.
The Company adopted Financial Accounting Standards Board ("FASB") Interpretation
No. 46, "Consolidation of Variable Interest Entities," on March 31, 2004, which
resulted in the consolidation of PCD as of that date. As a result, we recorded a
$1.6 million (net of benefit for income taxes of $1.0 million) non-cash
cumulative charge to recognize the prior losses of PCD during the first quarter
of 2004.
Net income of $68.5 million was generated in the third quarter of 2004, an
increase of $59.8 million from the comparable prior year period. Net income of
$155.3 million was generated in the nine months ended September 30, 2004, an
increase of $145.3 million from the comparable prior year period.
Segment Information
- -------------------
Energy Products Segment
- -----------------------
Energy product sales of $256.4 million for the third quarter of 2004 represent
an increase of $97.3 million, or 61.2%, compared to the prior year period.
Energy product shipments decreased 6,298 tons, or 2.9%, from 215,933 tons to
209,635 tons over the same period. Our energy product shipments decreased as we
raised our prices more aggressively than our competitors. Our average net
selling prices for energy products increased 65.9% from the comparable quarter
of the prior year, from an average of $737 per ton to $1,223 per ton. The U.S.
rig count increased from 1,088 active rigs for the third quarter of 2003 to
1,229 active rigs for the third quarter of 2004. The Canadian rig count
decreased from 383 active rigs for the third quarter of 2003 to 326 active rigs
for the third quarter of 2004. The increase in energy product sales was
primarily due to selling price increases including steel surcharges. See
"Overview."
Energy product sales of $658.6 million for the nine months ended September 30,
2004 represent an increase of $215.9 million, or 48.8%, compared to the prior
year period. Energy product shipments increased 8,525 tons, or 1.3%, from
637,292 tons to 645,817 tons over the same period. Energy product shipments
primarily increased due to the U.S. rig count increasing from 1,006 active rigs
for the nine months ended September 30, 2003 to 1,170 active rigs for the nine
months ended September 30, 2004. Canadian rig count decreased slightly from 360
active rigs for the nine months ended September 30, 2003 to 352 active rigs for
the nine months ended September 30, 2004.
24
Overall average net selling prices for energy products increased 46.8% for the
nine months ended September 30, 2004 from the comparable period of the prior
year, from an average of $695 per ton to $1,020 per ton. The increase in energy
product sales was primarily due to selling price increases including steel
surcharges and strengthening market conditions. See "Overview."
Energy product cost of goods sold of $182.8 million for the third quarter of
2004 represent an increase of $47.1 million, or 34.7%, compared with the prior
year period. The increase was primarily due to steel surcharges implemented by
our suppliers. See "Overview." Gross profit for energy products was $73.6
million for the quarter ended September 30, 2004 compared to a gross profit of
$23.4 million for the prior year period. Gross profit per ton primarily
increased due to higher selling prices including steel surcharges. Gross profit
was $351 per ton for the third quarter of 2004 as compared to $108 per ton in
the comparable prior year period, reflecting stronger selling prices including
steel surcharges. Energy product gross profit margin percentage was 28.7% for
the quarter ended September 30, 2004, compared to a gross profit margin
percentage of 14.7% for the prior year period. Gross profit per ton primarily
increased due to strengthening market conditions in our energy product lines and
the sale of lower cost inventory at higher selling prices charged by the Company
in response to increasing steel costs and strong market conditions. We expect
the higher steel costs will continue to flow through our inventory in the fourth
quarter of 2004 and the first quarter of 2005. Depending on the conditions in
our respective product markets and to the extent that higher steel costs cannot
be absorbed through increased sale prices, these higher steel costs could impact
our gross profit margins in the fourth quarter of 2004 and the first quarter of
2005.
Energy product cost of goods sold of $488.1 million for the nine months ended
September 30, 2004 represent an increase of $92.6 million, or 23.4%, compared
with the prior year period. The increase was primarily due to increased product
shipments and steel surcharges implemented by our suppliers. See "Overview."
Gross profit for energy products was $170.5 million for the nine months ended
September 30, 2004 compared to a gross profit of $47.2 million for the prior
year period. Gross profit per ton primarily increased due to higher selling
prices including steel surcharges. Gross profit was $264 per ton for the nine
months ended September 30, 2004 as compared to $74 per ton in the comparable
prior year period, reflecting stronger selling prices including steel
surcharges. Energy product gross profit margin percentage was 25.9% for the nine
months ended September 30, 2004, compared to a gross profit margin percentage of
10.7% for the prior year period. Gross profit per ton primarily increased due to
strengthening market conditions in our energy product lines and the sale of
lower cost inventory at higher selling prices charged by the Company in response
to increasing steel costs and strong market conditions. We expect the higher
steel costs will continue to flow through our inventory in the fourth quarter of
2004 and the first quarter of 2005. Depending on the conditions in our
respective product markets and to the extent that higher steel costs cannot be
absorbed through increased sale prices, these higher steel costs could impact
our gross profit margins in the fourth quarter of 2004 and the first quarter of
2005.
Industrial Products Segment
- ---------------------------
Industrial product sales of $144.3 million for the third quarter of 2004
represent an increase of $76.6 million, or 113.1%, compared with the prior year
period. Industrial product shipments decreased 11,892 tons, or 11.3%, from
105,103 tons to 93,211 tons over the same periods. Overall average net selling
price for industrial products increased 140.4% in the quarter ended September
30, 2004 from the comparable quarter of the prior year from an average of $644
per ton to $1,548 per ton. The increase in industrial product sales resulted
from strengthening market conditions and steel surcharges charged to our
customers to offset steel cost increases implemented by our major steel
suppliers. Product shipments decreased as we raised our prices more aggressively
than our competitors. See "Overview."
Industrial product sales of $401.5 million for the nine months ended September
30, 2004 represent an increase of $203.1 million, or 102.4%, compared with the
prior year period. Industrial product shipments increased 26,597 tons, or 8.7%,
from 304,449 tons to 331,046 tons over the same periods. Overall average net
selling price for industrial products increased 86.0% for the nine months ended
September 30, 2004 from the comparable period of the prior year from an average
of $652 per ton to $1,213 per ton. This increase in industrial product sales and
shipments resulted from strengthening market conditions, our ability to obtain
steel, and higher selling prices including steel surcharges. See "Overview."
25
Industrial product cost of goods sold of $83.9 million in the third quarter of
2004 represents an increase of $22.6 million, or 36.9%, from the prior year
period. The increase was primarily due to higher steel costs. See "Overview."
Gross profit for industrial products of $60.4 million for the quarter ended
September 30, 2004 compared to a gross profit of $6.4 million for the prior year
period. Gross profit per ton primarily increased due to higher selling prices
including steel surcharges partially offset by higher steel costs. Gross profit
was $648 per ton in the quarter ended September 30, 2004 as compared to $61 per
ton in the comparable prior year period, primarily reflecting stronger selling
prices including steel surcharges. Industrial product gross profit margin
percentage was 41.9% for the quarter ended September 30, 2004, compared to 9.5%
gross profit margin during the prior year period. Gross profit per ton primarily
increased due to strengthening market conditions in our industrial product lines
and the sale of lower cost inventory at higher selling prices charged by the
Company in response to increasing steel costs and strong market conditions. We
expect the higher steel costs will continue to flow through our inventory in the
fourth quarter of 2004 and the first quarter of 2005. Depending on the
conditions in our respective product markets and to the extent that higher steel
costs cannot be absorbed through increased sale prices, these higher steel costs
could impact our gross profit margins in the fourth quarter of 2004 and the
first quarter of 2005.
Industrial product cost of goods sold of $248.2 million for the nine months
ended September 30, 2004 represents an increase of $62.9 million, or 33.9%, from
the prior year period. The increase was primarily due to increased product
shipments and higher steel costs. See "Overview." Gross profit for industrial
products of $153.3 million for the nine months ended September 30, 2004 compared
to a gross profit of $13.1 million for the prior year period. Gross profit per
ton primarily increased due to higher selling prices including steel surcharges
partially offset by higher steel costs. Gross profit was $463 per ton for the
nine months ended September 30, 2004 as compared to $43 per ton in the
comparable prior year period, primarily reflecting stronger selling prices
including steel surcharges. Industrial product gross profit margin percentage
was 38.2% for the nine months ended September 30, 2004 compared to 6.6% gross
profit margin during the prior year period. Gross profit per ton primarily
increased due to strengthening market conditions in our industrial product lines
and the sale of lower cost inventory at higher selling prices charged by the
Company in response to increasing steel costs and strong market conditions. We
expect the higher steel costs will continue to flow through our inventory in the
fourth quarter of 2004 and the first quarter of 2005. Depending on the
conditions in our respective product markets and to the extent that higher steel
costs cannot be absorbed through increased sale prices, these higher steel costs
could impact our gross profit margins in the fourth quarter of 2004 and the
first quarter of 2005.
LIQUIDITY AND CAPITAL RESOURCES
- --------------------------------------------------------------------------------
Working capital at September 30, 2004 was $435.2 million, and the ratio of
current assets to current liabilities was 3.4 to 1.0. Working capital at
December 31, 2003 was $253.7 million, and the ratio of current assets to current
liabilities was 3.8 to 1.0. The decrease in the working capital ratio for the
nine months ended September 30, 2004 was primarily due to a $2.5 million
increase in cash and cash equivalents, a $40.3 million increase in short-term
investments, a $55.8 million increase in accounts receivable, a $172.3 million
increase in inventory offset by a $40.9 million increase in accounts payable, a
$39.8 million increase in income taxes payable and a $10.0 million increase in
accrued liabilities. The primary reason for the increase in accounts receivable
was an increase in pricing levels and increases in selling prices during the
third quarter of 2004. The primary reason for the change in inventory and
accounts payable is the higher cost of steel experienced in 2004 compared to
2003. We raised our selling prices to offset increases in steel cost. Cash
provided by operating activities was $57.8 million for the nine months ended
September 30, 2004.
Cash used by investing activities was $75.2 million for the nine months ended
September 30, 2004, which was attributable to expenditures on property, plant
and equipment of $19.3 million, the purchase of Texas Arai for $20.4 million,
partially offset by $5.6 million of proceeds for the sale of the Longview,
Washington facility, and the purchase of short-term investments for $40.3
million.
Cash provided by financing activities was $19.5 million for the nine months
ended September 30, 2004 as we increased our borrowings on our revolving credit
facility by $17.6 million primarily to make estimated tax payments.
We have a revolving credit facility (due on March 31, 2006) providing a
revolving line of credit for up to a $185.0 million. At September 30, 2004, we
had an outstanding balance of $67.6 million against the line and outstanding
26
letters of credit under this agreement of $3.9 million. Interest is payable
monthly at either the U.S. or Canadian prime rate, the Bankers' Acceptance rates
plus stamping fees or the LIBOR rate, all adjusted by an interest margin,
depending upon certain financial measurements. Under the revolving senior credit
facility, we can borrow an amount based on a percentage of eligible accounts
receivable, eligible inventory and property, plant and equipment reduced by
outstanding letters of credit. The additional available borrowing under the
senior credit facility was approximately $133.0 million and $101.1 million as of
December 31, 2003 and September 30, 2004, respectively. The change in
availability from December 31, 2003 to September 30, 2004 was a result of
increased borrowings during 2004 in the amount of $17.6 million, an increase in
outstanding letters of credit during 2004 in the amount of $2.1 million and the
required reserves (as defined in the credit agreement) during 2004 in the amount
of $12.2 million. The senior credit facility includes a restrictive covenant
requiring a minimum fixed charge coverage ratio if availability falls below
$30.0 million. Also, if availability falls below $50.0 million, the debt will be
classified as current. The senior credit facility also limits capital
expenditures to $30.0 million per year and limits our ability to pay dividends,
create liens, sell assets or enter into transactions with affiliates without the
consent of the lenders.
We anticipate we will comply with the covenants in our senior credit facility
and other debt instruments in 2004 and beyond. We believe our projections for
2005 are based on reasonable assumptions and we believe that it is unlikely we
would default absent a material negative event affecting us, or our industry and
the economy as a whole.
In June 2003, the Company issued $120.0 million of contingent convertible,
senior subordinated notes (the "Convertible Notes") due June 15, 2033. The
Company pays interest semi-annually on the Convertible Notes at the rate of 4.0%
per annum. Beginning with the six-month interest period commencing on June 15,
2008, the Company will pay contingent interest during a six-month interest
period if the average trading price of the Convertible Notes equals or exceeds
130.0% of the principal amount of the Convertible Notes during a specified
period prior to such six-month interest period. The Convertible Notes are
general unsecured obligations of the Company and are subordinated to the
Company's present and future senior indebtedness.
Our net debt to capitalization ratio (the sum of our current and long-term debt,
net of cash and cash equivalents and short-term investments compared to the sum
of our stockholders' equity and our current and long-term debt, net of cash and
cash equivalents) decreased from 27.9% at December 31, 2003 to 18.1% at
September 30, 2004. This ratio is a measure of our long-term liquidity and is an
indicator of our financial flexibility.
The Company has announced its plan to consolidate the Republic Conduit
operations into a state-of-the-art facility located in the Midwestern U.S. Two
sites remain under consideration and we anticipate that final selection will
occur during the fourth quarter of 2004. The consolidation is expected to cost
approximately $62.0 million, consisting primarily of land, building and
equipment costs. The Company expects that it will purchase new equipment and
upgrade existing equipment to improve efficiency and productivity of the conduit
manufacturing operations. Significant expenditures relating to such
consolidation are expected to commence in the fourth quarter of 2004 and are
expected to be completed in late 2005. The Company has obtained the necessary
approvals from our senior lender for capital expenditures related to this
project in an amount up to $55.0 million in the aggregate for the years 2004 and
2005. The Company anticipates obtaining the necessary approvals from our senior
lender for the additional capital expenditures related to this project. The
approval from our senior lender for the capital expenditures for the
consolidation of the Republic Conduit operations does not impact our normal
annual limit on capital expenditures of $30.0 million dollars. The Company
anticipates paying severance and stay bonuses to certain Republic Conduit
employees, which will be expensed as incurred. This consolidation plan is in the
process of being finalized. The Company also anticipates that any impairment
charges necessary as a result of the relocation or abandoning various pieces of
equipment will not be material.
Depending on the timing of the land purchase for the Republic Conduit
consolidation, our capital budget for 2004 could range from $22.0 million to
$27.0 million; of which $19.3 million was expended during the nine-month period
ended September 30, 2004. The capital budget included $6.5 million for upgrading
one of our mills at Prudential. The remaining capital budget included new
equipment for our existing manufacturing facilities and to continue full
integration of our recent acquisitions. We expect to meet ongoing working
capital and the capital expenditure requirements from a combination of cash flow
from operating activities and available borrowings under our revolving credit
facility.
27
Consistent with the Company's business strategy, we currently intend to retain
earnings to finance the growth and development of our business, and we do not
anticipate paying cash dividends in the near future. Any payment of cash
dividends in the future will depend upon our financial condition, capital
requirements and earnings as well as other factors the Board of Directors may
deem relevant. Our long-term revolving credit facility with commercial lenders
restricts the amount of dividends we can pay to our stockholders.
CRITICAL ACCOUNTING ESTIMATES
- --------------------------------------------------------------------------------
The preparation of the financial statements in accordance with generally
accepted accounting principles requires management to make judgments, estimates
and assumptions regarding uncertainties that affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities and the
reported amounts of revenues and expenses.
Areas of uncertainty that require judgments, estimates and assumptions include
the valuation of goodwill, the collectibility of accounts receivable, income tax
and pension plan matters.
Management uses experience and all available information to make these judgments
and estimates; however, actual results will inevitably differ from the estimates
and assumptions used to prepare the Company's financial statements at any given
time. Despite these inherent limitations, management believes "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the financial statements and notes contained in this report provide a meaningful
and fair perspective of the Company.
The Company's critical accounting policies and estimates are more fully
described in our Annual Report on Form 10-K for the year ended December 31,
2003, beginning on page 25. The Company's critical accounting policies and
estimates did not change during the third quarter of 2004. Management believes
the application of these policies on a consistent basis enables the Company to
provide the users of the financial statements with useful and reliable
information about the Company's operating results and financial condition.
28
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------------------
Interest Rate Risk
- ------------------
We are subject to interest rate risk to the extent we borrow against our
revolving credit facility with variable interest rates. However, we utilize an
interest rate swap agreement described below to moderate a portion of our
exposure. We do not use derivative financial instruments for trading or other
speculative purposes. Assuming the current level of borrowings at variable rates
and a two-percentage-point change in the average interest rate under these
borrowings and taking into account the swap agreement in place, it is estimated
that our interest expense for the quarter ended September 30, 2004 would not
have changed by a material amount. In the event of an adverse change in interest
rates, we would likely take actions, in addition to the swap agreement currently
in place, that would mitigate our exposure to interest rate risk; however, due
to the uncertainty of the actions that would be taken and their possible
effects, no such actions have been considered. Further, no consideration has
been given to the effects of the change in the level of overall economic
activity that could exist in such an environment.
We have entered into an interest rate swap agreement with a total notional
amount of $50.0 million that fixes the LIBOR-based variable rate in our senior
credit facility at 2.24% (before the applicable margin). The swap agreement
terminates on March 21, 2005. The swap is being accounted for as a cash flow
hedge under Statement of Financial Accounting Standards ("SFAS") No. 133.
Accordingly, the difference between the interest received and interest paid is
reflected as an adjustment to interest expense. Under the terms of the swap
agreement, the next settlement amount is not due until December 2004. At
September 30, 2004, the swap agreement is reflected in the accompanying
consolidated balance sheet in other accrued liabilities at its fair value of
$0.03 million. The unrealized loss on the fair value of the swap agreement is
reflected, net of taxes, in other comprehensive loss.
Steel Commodity Risk
- --------------------
We are also subject to commodity price risk with respect to purchases of steel.
Purchased steel represents approximately three quarters of our cost of goods
sold. As a result, the steel industry, which is highly volatile and cyclical in
nature, significantly affects our business. We expect our current replacement
cost of steel to flow through our cost of goods sold over the next two quarters.
See "Overview - Pricing and Costs of Our Products." In addition, we depend on a
few suppliers for a significant portion of our steel. Because steel is
ultimately a commodity, the loss of one of our significant steel suppliers or
the inability to obtain the necessary amount of steel could have a temporary
adverse effect on our ability to produce the quantity of products necessary to
sustain our market share, thus impacting our results of operations.
Foreign Currency Risk
- ---------------------
The Company's reported cash flows related to its Canadian operations are based
on cash flows measured in Canadian dollars converted to the U.S. dollar
equivalent based on published exchange rates for the period reported. The
Company believes its current risk exposure to the exchange rate movements, based
on net cash flows, to be immaterial.
We have entered into a foreign currency hedge agreement with a total notional
amount of $30.0 million that fixes the purchase of Canadian dollars into U.S.
dollars on July 21, 2004 at an exchange rate of 1.327. The objective of the
foreign currency hedge agreement relates to converting U.S. denominated debt
held by the Company's Canadian subsidiary into its functional currency. The
settlement date for the hedge agreement is January 18, 2005. The swap is being
accounted for as a cash flow hedge. Accordingly, the difference between the spot
rate at the inception of the contract and the forward rate is reflected as an
adjustment to interest expense during the duration of the contract. At September
30, 2004, the hedge agreement is reflected in the accompanying consolidated
balance sheet in other liabilities at its fair value of $(1.5) million. The
unrealized gain on the fair value of the hedge agreement is reflected in other
comprehensive income.
29
ITEM 4. CONTROLS AND PROCEDURES
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We are evaluating our system of internal controls over financial reporting to
allow management to report on, and our Independent Registered Public Accounting
Firm to attest to, our internal control system, and procedures, pursuant to
Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), and Section 404 of the Sarbanes-Oxley Act of 2002
("Section 404"). The Company's Chief Executive Officer and Chief Financial
Officer have performed and continue to perform system and process evaluation and
testing, with the participation of other members of the Company's management as
they deem appropriate, to comply with the rules and regulations of the Exchange
Act and Section 404.
During the evaluation, the Chief Executive Officer and Chief Financial Officer
discovered a potential significant deficiency in the design and operation of our
general computer controls related to security around access to certain parts of
the system. While overall access to our JD Edwards ERP system is secure, access
to sub-processes of the system may not be sufficiently limited. We believe
mitigating controls and procedures, which include manual controls and
reconciliations, are in place to detect errors that may result from
inappropriate access. Therefore, we do not believe the access security issue
will result in a material weakness. However, we are in process of implementing
certain changes to our security access to remediate this deficiency, including
role-based security and reviewing key financial sub-processes for inappropriate
access. Despite the measures we have taken to remediate this deficiency, we
cannot be certain that the remediation will be fully completed prior to December
31, 2004.
In addition, we are implementing a new, company-wide human resource and payroll
system in the fourth quarter of this year. Due to the timing of the
implementation, we cannot be certain that the related evaluation, testing, any
necessary remediation and the auditor's related attestation procedures will be
fully completed prior to December 31, 2004. Any findings that cannot be
remediated prior to year-end may result in a potential significant deficiency.
As a result of our findings to date and the implementation of our new system in
the fourth quarter, we are incurring additional expenses and a diversion of
management's time. While we anticipate being able to fully implement the
requirements relating to internal controls and all other aspects of Section 404
in a timely fashion, we cannot be certain as to the timing of completion of our
evaluation, testing and remediation actions or the impact of the same on our
operations since there is no precedent available by which to measure compliance
adequacy.
The Company maintains disclosure controls and procedures designed to ensure
information required to be disclosed in its periodic filings with the SEC is (a)
accumulated and communicated to the Company's management in a timely manner and
(b) recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms. Based on their evaluation of these
disclosure controls and procedures, as of September 30, 2004, the Chief
Executive Officer and Chief Financial Officer concluded the Company's disclosure
controls and procedures are effective in all material respects in ensuring that
material information required to be disclosed in the periodic reports the
Company files with the Securities Exchange Commission is recorded, processed,
summarized and reported in a timely manner. During the quarter ended September
30, 2004, there was no change in the Company's internal control over financial
reporting that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
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ITEM 6. EXHIBITS
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Exhibit No. Description
10.1 Seventh Amendment to Amended and Restated Credit Agreement dated as of
August 18, 2004 among Registrant and its subsidiaries, on the one
hand, and the Senior Lenders, on the other hand.
15.1 Letter re: Unaudited Interim Financial Information.
31.1 Chief Executive Officer certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Chief Financial Officer certification pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Chief Executive Officer certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Chief Financial Officer certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Maverick Tube Corporation
-------------------------------------------------
(Registrant)
Date: November 8, 2004 /s/ C. Robert Bunch
-------------------------------------------------
C. Robert Bunch, President
and Chief Executive Officer
(Principal Executive Officer)
Date: November 8, 2004 /s/ Pamela G. Boone
-------------------------------------------------
Pamela G. Boone, Vice President - Finance
and Administration and Chief Financial Officer
(Principal Financial and Accounting Officer)
32
EXHIBIT INDEX
Exhibit No. Description
10.1 Seventh Amendment to Amended and Restated Credit
Agreement dated as of August 18, 2004 among
Registrant and its subsidiaries, on the one hand, and
the Senior Lenders, on the other hand.
15.1 Letter re: Unaudited Interim Financial Information.
31.1 Chief Executive Officer certification pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Chief Financial Officer certification pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Chief Executive Officer certification pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Chief Financial Officer certification pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
33